Dedicated to advancing the business of franchising through the sharing of information and ideas.

Regulatory Compliance

10/12/2016

California Assembly Bills 1782 and 2637, which would have improved the regulatory climate for franchises in the state, have been vetoed by Governor Jerry Brown after being passed by an overwhelming majority of the legislature.

Assembly Bill 1782 would have created a new exemption to the California Franchise Investment Law (the "CFIL") that would have permitted a franchisor or prospective franchisor to exhibit at a trade show in California without first having to register with the Department of Business Oversight. AB 1782 provided that a prospective or actual franchisor seeking to take advantage of this new exemption would be required to file an exemption form with the DBO (in a format the DBO determines) and post a sign in its booth at the trade show explaining that the franchisor is not registered, and that it must become registered before it can legally offer a franchise for sale in California.

AB 2637 would have amended the CFIL by changing the existing law regarding negotiated sales. California has a unique requirement that requires a franchisor to make certain disclosures to prospective franchisees regarding terms that were negotiated with prior California franchisees that amended the standard agreement contained in the registered FDD. The bill would have modified the exemption by permitting a franchisor to freely negotiate with California prospects so long as the franchisor: 1) included a statement in its FDD that CA law does not prohibit a franchisor from negotiating, or require a franchisor to negotiate, the standard franchise agreement or other agreements contained in the FDD; 2) retained copies of the material negotiated terms for a period of 5 years; and 3) certified in its annual renewal application that it has complied with the statute. The requirement that a franchisor disclose (in any form) terms that it has negotiated previously with other California franchisees would have been deleted.

AB 1782 (Limited Trade Show Exemption): "Registration gives the Department of Business Oversight the opportunity to review franchise disclosure documents and ensure that franchisors are providing accurate information to potential customers. Allowing unregistered franchisors to market at these events without verifying their eligibility to do business in California is a step in the wrong direction."

AB 2637 (Negotiated Sales): "While it is important to promote bringing new businesses into California, doing so at the expense of transparency could be detrimental to potential franchisees, as this bill proposes to do. The current process, which allows the Department to review contract changes, ensures that franchisees are not placed at a disadvantage in their final agreement."

These vetoes disappointed many in the franchise community. The IFA issued the following press release in response:

It is disappointing Gov. Brown has chosen to reject these bipartisan supported bills, both having passed the legislature unanimously, rather than promote franchise small business growth in California. Given the unanimous bipartisan support for this bill in the legislature, his veto of this pro-business legislation sends a signal to franchises and other small businesses that California is not open for business.

AB 2637 would have simplified the process by which prospective franchisees and franchisors negotiate with each other, thereby promoting small business growth in California. Current California law has a chilling effect on negotiations between prospective franchisees and franchisors. Passage of AB 1782 would have put California in a better position to retain and attract trade shows, while also leading to greater exposure of entrepreneurial opportunities to California residents. For years the West Coast Franchise Expo was hosted in California, but has now moved to Denver, Colorado.

We are interested to see and understand the Governor's reasoning to veto legislation that was unanimously passed by the bipartisan legislature and supported by California franchisees and franchisors.

As a member of the FLC and having testified several times before the California Legislature in support of these bills, I am personally very disappointed in the vetoes. It is unlikely that these bills will be brought back on the table for consideration for many years.

03/08/2016

Today I attended the International Franchise Association's fourth annual California Franchising Day. During the course of the day, I had the opportunity to meet with Assembly Members (or their representatives) Hadley, Bigelow, Brough, Miller, Baker, and Gipson, and Senator Nguyen. My group talked with them about the many issues facing franchisees and franchisors in California, including concerns about rising minimum wages, high workers' compensation premiums, and other regulatory issues facing industry members in California.

We also talked to the Assembly members and Senator about Assembly Bills 1782 and 2637, and specifically about how those bills (if passed) will improve franchising and franchise regulations in California. I found all of the Assembly Members and Senators to be very receptive to the two pending bills and the reasons behind them, and willing to listen regarding the other issues that face members of the franchise industry in California.

I remain hopeful that ABs 1782 and 2637 will find support in the legislature, and that they will not be opposed by any major interest groups as they move forward. As promised, I will keep you posted on the progress of those bills here.

03/07/2016

The International Franchise Association's (IFA) fourth annual California "Franchising Day" is set for March 8, 2016. The goal of Franchising Day is to inform California legislators about some of the key issues affecting the franchise industry. This year, the IFA's Franchising Day will "feature meetings with legislators and staff, allowing members of the franchise community to meet directly with lawmakers to discuss the benefits of franchising in California, as well as the legislative issues facing their businesses."

There are currently two key franchising bills in California. One, California Assembly Bill 1782, seeks to create a new exemption to the California Franchise Investment Law relating to franchise trade shows in the state. If enacted, this new law would permit franchisors and prospective franchisors to exhibit at franchise trade shows in California without having to first apply for a full franchise registration with the Department of Business Oversight.

The second pending bill is Assembly Bill 2637, which is designed to improve the state's law on negotiated franchise sales. As described in my previous posts here and here, the law -- intended to help California franchisees to give them an advantage during negotiations with their franchisors -- actually hurts franchisees in the state because many franchisors would rather refuse to negotiate completely than comply with the law, which franchisors view as burdensome. AB 2637 seeks to improve this situation by permitted franchisors and franchisees to freely negotiate with one another for so long as the franchisor meets certain simple disclosure and recordkeeping requirements.

Forward Franchising will be following these new bills and developments, and will keep you posted on them here.

Termination for “Good Cause” Restricted to Substantial Compliance. Under the CFRA, a franchisor is permitted to terminate a franchise prior to the expiration of its term only for “good cause,” which includes (but is not limited to) the failure of a franchisee to comply with any lawful requirement of the franchise agreement after being given notice and an opportunity to cure the failure. As amended, “good cause” would be limited to the failure of the franchisee to substantially comply with the lawful requirements of the franchise agreement.

60 Day Cure Period. A franchisee will have a mandatory period of at least 60 days to cure a material default under the franchise agreement after receiving notice of the default from the franchisor, which cure period would apply in all but a few defined circumstances. Importantly, this 60 day period would not apply, and the CFRA would continue to permit immediate termination without the franchisee having further opportunity to cure, where the franchisee fails to pay amounts due to the franchisor or its affiliate within five days after receiving notice that the fees are overdue.

Right of Sale. A franchisor would be prohibited from withholding its consent to the sale of an existing franchise except where: (a) the buyer does not meet the franchisor’s standards for new or renewing franchisees; or (b) the parties fail to comply with the transfer provisions specified in the franchise agreement.

Notification of Approval / Disapproval of Proposed Sale. A franchisor would be required to notify the requesting franchisee of its approval or disapproval of a contemplated sale of a franchise within 60 days of receiving from the franchisee certain mandated forms and information regarding the sale. The franchisor would further be required to communicate to the selling franchisee its standards for approval of new or renewing franchisees, as well as the reasons for disapproval if the sale is not approved. If a franchisor does not provide its written approval or disapproval with the 60 day period, the sale will be deemed to have been approved by the franchisor.

Payment of Fair Market Value for Franchised Business, Plus Damages. In the event a franchisor terminates or fails to renew a franchisee in violation of the CFRA, the franchisor will be required to pay the franchisee "the fair market value of the franchised business and franchise assets and any other damages caused" by the franchisor's violation of the CFRA.

Critically, AB 525, if signed by Gov. Brown, will not apply retroactively to existing franchise contracts. AB 525's application will be limited to franchise agreements entered into or renewed after January 1, 2016, or to franchises of an indefinite duration that may be terminated without cause.

08/27/2015

Last night I reviewed a franchise agreement and found a surprising, and illegal, provision buried deep in the contract. If ever there was a compelling case for being careful when you are choosing legal counsel, I just found the provision that makes it.

But first, some background. My law practice involves representing both franchisors and prospective franchisees. For franchisors, I primarily draft franchise disclosure documents (“FDDs”) and franchise agreements; I assist my clients in obtaining franchise state registrations; and I assist them with day-to-day issues that arise in running their businesses. For prospective franchisees, I will review their proposed franchise agreements and FDDs and help them understand what they will be committing to do if they decide to buy the franchise. If the franchise company is willing to negotiate, I help prospective franchisees through that process.

I find that reviewing other companies’ FDDs and franchise agreements also helps me in my practice for franchisors; it’s always instructive to see what other industry leaders are doing. I have noticed that, in a small minority of systems, some franchisors go well beyond what is legally permitted to be included in the franchise agreement and include provisions that unquestionably violate the FTC Franchise Rule (the “Franchise Rule”) as well as various state franchise laws.

The Provision

If you’re on either side of the franchise relationship, you should know if your contract has a provision like this one. Pull out your franchise agreement now. Go ahead, I’ll wait.

You have it now? Good. Here’s the provision we’re looking for:

Release of Prior Claims. By executing this Franchise Agreement, Franchisee, and each successor of Franchisee under this Franchise Agreement forever releases and discharges Franchisor and its Affiliates, Its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors. representatives, employees and agents, from any and all claims of any kind, in law or In equity, which may exist as of the date of this Franchise Agreement relating to, in connection with, or arising under this Franchise Agreement or any other agreement between the parties, or relating In any other way to the conduct of Franchisor, its Affiliates, its designees, franchise sales brokers, if any, or other agents, and their respective officers, directors, representatives, employees and agents prior to the date of this Franchise Agreement, including any and all claims, whether presently known or unknown, suspected or unsuspected, arising under the franchise, business opportunity, securities, antitrust or other laws of the United States, any stale or locality.

In plain English: “you, the franchisee acknowledge that we, the franchisor, may have lied to you and might be lying to you right now. Our entire FDD might be one of the greatest works of fiction since Moby Dick. You agree, however, that you waive all your legal rights to take action against us based on those lies, even if you have invested hundreds of thousands of dollars of your hard-earned money in this phony business.” Wow.

Do you have that one in your franchise agreement? You might have to do a bit of hunting for it. You would think something like that would be on the first page, bolded, in caps, with a box around it and perhaps accompanied by a self-lighting sparkler that draws your attention directly to the provision when you open the contract. But no, in the case of the contract in which I found this provision, it was buried on page 36 of a 39-page franchise agreement, with no particular emphasis placed upon it.

I will never include a provision like this in a franchise agreement I draft, nor will I ever recommend that a prospective franchise buyer sign a contract when it includes this provision. Why? It's not only unfair, but it's also illegal under the Franchise Rule and under various state franchise laws.

The Problem with Having the Provision

Now, I highly doubt that in most situations, the franchisor even knows this provision is in its franchise agreement. Most start-up franchise companies trust their franchise counsel to draft the agreement and don’t necessarily carefully consider each provision in the contract. This sort of provision is typically created by counsel, who is seeking to protect his or her client. An admirable goal, to be sure.

03/17/2015

The top stories in the franchise world continue to be about efforts by the cities of Seattle, Chicago, and others in raising the minimum wage with laws that discriminate against small business owners who own franchises. For the full story, see some of my previous blog posts on the issue. These laws are a serious concern for franchisees and franchisors alike.

In brief, these laws (which are written substantially the same way in the different cities that have adopted them) require small businesses to raise the minimum wage of their workers from the current level to $15 an hour. Under these new ordinances, businesses with more than 500 employees have 3 to 4 years to increase the minimum wage to the new $15/hour level, while "small businesses," defined as businesses with fewer than 500 employees, have up to 7 years to reach the new level.

The problem? For the purpose of calculating the "500 employees" number, all franchises in the same system are counted together. The net result of this is that these locally-owned small businesses with a few employees, which also happen to be franchises, are being discriminated against as compared to their non-franchised counterparts.

After reading some of my blog posts on the subject, another franchise attorney (one who exclusively represents franchisees) commented to me that these laws, which treat franchises differently than similarly situated non-franchise small businesses, could arguably be viewed as "industry specific" laws for the purposes of Item 1 of a franchisor's Franchise Disclosure Document (FDD). I can see the argument on both sides of that point.

The Federal Trade Commission's (FTC) Franchise Rule requires a franchisor to state in Item 1 of its FDD "any laws or regulations specific to the industry in which the franchise business operates." The FTC has elaborated on this requirement by saying that laws applying to all businesses generally do not need to be disclosed; instead, "only laws that pertain solely and directly to the industry in which the franchised business is a part must be disclosed in Item 1."

The minimum wage laws adopted by some cities like Seattle target franchises by treating them differently from other similarly-situated small businesses; laws that are specific to a certain "industry" are the types of laws that need to be disclosed in Item 1.

So, the question then becomes: is franchising as a whole an "industry?" Are these the types of laws the FTC was contemplating when creating the Item 1 disclosure requirement? Should Item 1 of a franchisor's FDD should disclose these laws?

11/30/2014

Earlier this year, the California Department of Business Oversight (DBO) launched a new electronic filing portal that franchisors and other companies can use to file franchise, securities, and other business documents for California. Having personally used it for a number of franchise-related filings, I can tell you that the portal was difficult to use and full of flaws. In fact, because of problems with uploading documents and managing filings for my franchisor clients, in some instances I was forced to send paper copies of documents to the DBO -- even though I had already e-filed them through the portal.

The good news is that the DBO has been listening to our complaints and making changes to the portal -- just in time for franchise renewal season. The latest update now makes it possible for a single law firm to register and file documents for multiple franchise companies. This is a vast improvement from the prior version, which required outside franchise counsel (like me) to register a different account for each franchisor I represent. Now, a franchise attorney will be able to manage multiple California franchise registrations through one account.

Here is the text of the DBO's press release (dated November 14, 2014) on the latest updates to DOCQNET:

DBO Self-Service Portal Users:

Based on feedback the Department of Business Oversight (DBO) received from DBO self-service portal users like you, the DBO will modify the portal to make the Franchise or Securities notice filing process more convenient and user-friendly. Beginning on Monday, November 17, 2014 firms that file multiple franchise or securities notices, such as the Limited Offering Exemption Filing under Corporations Code Section 25102(f), will have the option to submit multiple filings under a single registered account. The notice filing history and payment history for 25102(f) filings will be available to you in the online portal. However, please note that the notice filing history and payment history for any other notice filing is not available.

When you register (sign up) on the portal, you’ll be given the option to select from one of two registration links:

1) To register as a Financial Services Licensee, as a securities issuer or franchisor filing on your own behalf, or a firm submitting Franchise registration applications or securities permit applications, you will go through the same registration process that exists currently, where both contact information and information about the Issuer/Licensee are required for registration.

2) To register a law firm seeking to file franchise and securities notices for multiple issuers, you will be asked to provide only your law firm’s information and desired username. You will provide Issuer information with each individual filing.

If you have previously registered and filed multiple times (and therefore have multiple accounts), the Department will be combining your previous filings under a single account. We will send you a follow up email by Monday, November 17 with the username of the account that has been retained. If you choose not to continue to use that username, you can still create a new single user account to submit all future filings.

Other features and changes include:

The filing summary preview page for 25102(f) notices will now have a button to select a printer-friendly version of the page

Issuer Representative information will be auto-populated using the information you provided at the time of registration

We hope these changes further improve your experience using the DBO self-service portal. For more information, please visit the Frequently Asked Questions page.

06/24/2014

As an attorney who represents franchisors, a significant part of my practice is drafting franchise agreements and franchise disclosure documents. Once these documents are completed, I also help franchisors comply with state laws by filing and maintaining their registrations in the various states that have franchise registration laws. As a result, much of my time (particularly during the first half of the year) is spent dealing with franchise regulators in various states.

During my years of practice, I have seen a number of common mistakes made by both start-up and established franchisors in their Franchise Disclosure Documents (“FDDs”). Many of these mistakes, which can cause delays in a franchisor’s ability to obtain registration, are easily avoided. Make them, and state regulators will refuse to register your franchise offering – sending you a comment letter requiring you to correct your errors before issuing a registration permit. Avoid them, and your time to obtaining registration may be cut down by weeks, or even months.

A common FDD mistake is failure to list all “Other Fees” in Item 6. Item 6, entitled “Other Fees,” is where a franchisor must disclose all fees, other than initial fees, that are paid to or imposed by the franchisor. Specifically, in Item 6 a franchisor is directed to disclose “all other fees that the franchisee must pay to the franchisor or its affiliates, or that the franchisor or its affiliates impose or collect in whole or in part for a third party.” The franchise company must list the type of the fee, state the amount (either a fixed amount or a formula used to determine that amount), state the due date, and make any remarks, definitions, or caveats regarding the fee.

Many franchisors do not follow instructions and fail to list all “other fees” in Item 6. These mistakes typically come in two varieties.

1. Common Mistake #1: Failure to List All “Other Fees” Paid to the Franchisor or its Affiliates

The first type of mistake is that the franchisor or its counsel fails to list all of the fees that could be charged during the life of the franchise according to the franchise agreement. In these situations, the franchisor may list only the more “obvious” fees like the royalty fee, advertising fund fee, technology fee, and the like – the fees that are typically identified in a section of the franchise agreement devoted specifically to listing fees.

The problem with this approach is that often, a number of other possible payments are hidden within other section of the franchise agreement, and these amounts clearly fall within the definition of “other fees” in Item 6.

There can be a multitude of fees charged that may be hiding in the franchise agreement but need to be disclosed in Item 6. Some examples:

The franchisor charges a “relocation fee” in the event that the franchisee wants to relocate the franchised business.

The franchisor charges a mark-up fee if the franchisor is required to obtain insurance for the franchisee, because the franchisee failed to purchase insurance on its own.

If the franchisor conducts an audit of the franchised business that shows the franchisee has understated its gross revenue to the franchisor, the franchisor charges the franchisee for the cost of the audit (in addition to the other rights that it retains under those circumstances).

The franchisor charges a fee for the franchisee to send a replacement manager to attend the franchisor’s initial training program.

The franchise agreement has a liquidated damages provision that requires the franchisee to pay a set amount if the franchise agreement is terminated early due to the franchisee’s material uncured breach of the contract.

The franchisor requires the franchisee to pay for or reimburse the franchisor for the cost of advertising, marketing or promotional materials provided by the franchisor.

This is only a partial list of the types of fees that can fall under the category of “other fees.” I have seen many FDDs where franchisors will clearly charge these fees, but fail to list or disclose them in Item 6.

05/27/2014

As an attorney who represents franchisors, a significant part of my practice is drafting franchise agreements and franchise disclosure documents. Once these documents are completed, I also help franchisors comply with state laws by filing and maintaining their registrations in the various states that have franchise registration laws. As a result, much of my time (particularly during the first half of the year) is spent dealing with franchise regulators in various states.

During my years of practice, I have seen a number of common mistakes made by both start-up and established franchisors in their Franchise Disclosure Documents (“FDDs”). Many of these mistakes, which can cause delays in a franchisor’s ability to obtain registration, are easily avoided. Make them, and state regulators will refuse to register your franchise offering – sending you a comment letter requiring you to correct your errors before issuing a registration permit. Avoid them, and your time to obtaining registration may be cut down by weeks, or even months.

The Disclosure Requirement

On the top of the list of these common FDD mistakes is the franchisor’s failure to comply with the requirements for Item 2. Item 2, entitled “Business Experience,” is where a franchisor must list employment history of certain of its key officers, managers, directors, and employees. The instruction for completing Item 2 is a simple one:

Disclose by name and position the franchisor’s directors, trustees, general partners, principal officers, and any other individuals who will have management responsibility relating to the sale or operation of franchises offered by this document. For each person listed in this section, state his or her principal positions and employers during the past five years, including each position’s starting date, ending date, and location.

That’s it – that is the entire instruction for Item 2. The instruction does not call for the franchisor to give the entire resume, or even a mini biography, for its key personnel. But that’s exactly what many franchisors tend to do.

Common Mistakes in Item 2

The franchisor’s natural tendency in Item 2 is to use it as a sales tool – explaining why and how its key people are well-qualified, outstanding individuals with a long history of leading successful companies, and why they are great human beings, to boot. Here’s an example of how a non-compliant, overly-descriptive Item 2 might look:

Jules Winnifield, President

Jules has been the President of Jack Rabbit Slim’s Franchising Company for six years, and has been the driving force behind growing our franchise system from two locations to seventy-five. Before coming to work for Jack Rabbit Slim’s, Jules was the Chief Operating Officer of Red Apple Security, one of the largest private security companies in the world. During his eight years at Red Apple, Jules was responsible for a 22% increase in revenue company-wide. Jules earned his Ph.D in Behavioral Psychology from the University of Santa Cruz in 1992. In addition to his hobbies, which include walking the earth and memorizing passages from important works of literature, Jules enjoys spending time with his wife, Mia, and his children, Marsellus and Lance.

So what’s wrong with the above description? A lot. First, it provides only a small portion of the information called for by the instructions in Item 2. While it does at least describe where Jules has been employed for the last five years, it doesn’t tell you the dates of employment or where those positions were located. Second, the listing reads like a sales pitch, telling the prospective franchisee why Jules is so well-qualified for his current position. Nothing in the instructions for Item 2 asks the franchisor to provide that information. Third, the franchisor has provided more than five years of work experience for Jules, going back more than thirteen years into Jules’s prior employment. Fourth, the Item 2 instructions do not call for educational experience – only work history. And in this situation, it’s not even clear that Jules’s doctoral degree is even relevant to his current line of business. Fifth, nothing in the guidelines asks a franchisor to provide information regarding the hobbies or family members of its key personnel.

You might think I’m exaggerating non-compliance with Item 2 when I list Jules’s hobbies, wife and children. I’m not. I’ve seen many franchisors provide exactly that type of information in Item 2 of their own FDDs.

How An Item 2 Disclosure Should Look

Here’s how an Item 2 disclosure should look:

Vincent Vega, Chief Executive Officer

Vincent has been our Chief Executive Officer since March 2012. Prior to becoming our CEO, Vincent was President of Butch’s Boxing Club in Inglewood, California, a position he held between December 2010 and March 2012. Before that, Vincent was the Vice President of Operations for McDonald’s in Amsterdam, the Kingdom of the Netherlands, a position that he held between October 2006 and December 2010.

The above Item 2 description is correct because it provides all of the information called for by the instructions, and only that information. Vincent’s work experience the location of each position he held is listed in the description, and his starting and ending dates with each employer (month and year are all that is necessary) are given. The disclosure gives enough information to cover his last five years of employment, and no more.

Conclusion

Avoid making these common mistakes in Item 2 of your own FDD, and you will have an easier time of getting registered in the registration states. While it may be tempting to include the extraneous information in Item 2, your doing so will increase the likelihood that you will obtain comment letters from those states, and that your registration will be delayed as a result.

05/20/2014

The California Department of Business Oversight ("DBO"), which oversees all franchise filings and registrations in the state, announced yesterday that it will be launching a new portal that will allow franchisors to electronically file franchise applications and exemption notices. The portal, named Document Quality Network ("DOCQNET"), will begin accept e-filed franchise registration and renewal applications (as well as exemption notices) beginning at 12 pm on June 18, 2014.

DOCQNET will replace the existing California Electronic Access to Securities Information and Franchise Information ("Cal-EASI") portal. DOCQNET will be an improvement on Cal-EASI because, while the latter portal allows users to view franchise applications and other franchise filing documents, it does not permit e-filing. Cal-EASI also required DBO employees to manually scan and upload franchise filings, which resulted in documents not being available on Cal-EASI until 4-6 months after they were filed. DOCQNET will likely result in faster access to electronically-filed franchise documents.

For more information about DOCQNET, visit the Department of Business Oversight page at www.dbo.ca.gov/DOCQNET.

Matthew Kreutzer is a Partner at Howard & Howard Attorneys and serves as Chair of the firm's Franchising, Distribution, and Antitrust Practice Group. Mr. Kreutzer, who is based in the firm's Las Vegas office, is a Certified Specialist in Franchise and Distribution Law by the State Bar of California's Board of Legal Specialization.

About This Blog

This blog is dedicated to advancing the franchising industry through the sharing of business, legal, and practical information and ideas. This blog is a service of Howard & Howard's Franchising, Distribution, and Antitrust Practice Group.